LNG hubs to make strange bedfellows

As plans to build a natural gas liquefaction (LNG) hub on the British Columbia coast move closer to reality this year, the market is buzzing with talk of new partnerships and takeovers involving Western Canadian gas producers, potentially sweeping up big names like Encana Corp.

The trend has the makings of the next big thing and could shake up the natural gas sector in Western Canada, where prices are languishing at disastrous levels and cash-strapped producers are motivated to make deals.

Oil majors like Royal Dutch Shell Group PLC and national oil companies like Malaysia’s Petronas are evaluating as many as five plans to build terminals in the Kitimat area to export LNG to Asian markets and will need to secure supplies to keep them full.

So far, they have secured about 17.8 trillion cubic feet (tcf) of resources in Western Canada, but will need 39 tcf to meet current plans, CIBC World Markets estimates in a recent report.

Canada’s West Coast and the U.S. Gulf of Mexico are seen as the two hot spots in the race to build North American export capacity, a nascent business made possible by the discovery of massive shale gas deposits.

Companies putting together LNG plants will likely look for natural gas supplies to use as feedstock, so their exposure is to the cost of producing them rather than the price of the commodity, Andrew Potter, executive director of institutional research at CIBC, said in an interview. “On balance, through 2012, we see this as a theme that gradually unfolds.”

The trend started last year, through partnerships involving companies like Progress Energy and Petronas; Nexen Inc. and Japan’s Inpex Corp., Penn West with Japan’s Mitsubishi Corp. and Korea Gas Corp. Last week, PetroChina purchased 20% of Shell’s Groundbirch natural gas asset in Northeast British Columbia.

Encana, which ended a $5.5-billion partnership with PetroChina last summer to develop shale gas in B.C. in an apparent dispute over control, could announce a new deal for the same assets as soon as Friday, coinciding with the release of its fourth-quarter results. Mike Graham, president of Encana’s Canadian division and one of the company’s most senior executives, resigned Tuesday, fuelling speculation about an announcement.

LNG players are crossing key decision points this year. The Kitimat LNG project, led by Apache Corp. with partners Encana and EOG Corp., is expected to make a final investment decision by the end of the year.

Shell and partners Mitsubishi Corp. of Japan, Korea Gas Corp. and PetroChina are expected to reveal their plans in the next few months.

The Douglas Channel project, a 50/50 partnership of Houston-based LNG Partners and the Haisla Nation that involves a floating facility, received regulatory approval last week.

Eric Nuttall, Toronto-based portfolio manager of Sprott Energy Fund, said a consolidation wave is almost a certainty because the groups behind the LNG plans are gas short and need to show they have reserves to secure project financing.

Either they become very active drillers or buy reserve-rich producers, he said.

With natural gas prices in the $2 per thousand cubic feet (mcf) level in Canada, and in the $12 to $13 mcf range internationally, they can afford to make rich offers, he said.

Robert Mark, vice-president at wealth management firm MacDougall, MacDougall & MacTier in Toronto, said the trend is just starting and will be pushed by the long-term nature and huge scale of the LNG business, which is dominated by very large companies requiring long term supply contracts before they go ahead with investments.

“You will continue to see the JVs happening, because there is still a match between capital-rich and reserve-poor national companies in Asia, and asset-rich, cash-poor companies in North America,” he said. “But once we get a better sense of the timeline of these projects, and when there is a hard date, I think then you will start to see consolidation.”

So far, the trend has progressed with little controversy, next to the opposition directed at oil sands purchases by Asian buyers with similar export plans. Bigger deals may test the comfort level of those affected, particularly in British Columbia, where the resource grab is playing out.

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